Mexican peso proves most reliable gauge of ‘Trump risk’
Swings in the value of the Mexican currency have accompanied various stages in the US presidential race
For the most accurate measure of the probability which financial markets attach to a victory of Donald Trump in the US presidential election on November 8, look no further than the Mexican peso.
In the days leading up to the first presidential debate on Monday, the currency – the most liquid, or actively traded, emerging market (EM) currency which also acts as a proxy for broader investor sentiment towards developing economies – extended its decline against the dollar, having already fallen a whopping 36 per cent versus the greenback since the start of 2015.
According to Bloomberg data, speculative bets against the peso in the week ending September 20 – six days before Monday’s debate and amid a narrowing of Hillary Clinton’s lead over Trump in the polls – surged to their highest level in 20 years while a gauge of the cost for investors to protect themselves against price swings over the next month shot up to 19 per cent (the highest in the world) just hours before the debate began.
Yet on Tuesday morning, when analysts declared Clinton the winner of the debate, the peso swiftly rebounded from its historic low against the dollar, rising more than 2 per cent, its strongest intraday gain since mid-February.
Make no mistake about it, the peso has become the most accurate gauge of “Trump risk”.
To be sure, movements in other currencies also reflected market perceptions that Trump – who espouses protectionist economic policies, vowed to renegotiate America’s trade agreements, in particular the North American Free Trade Agreement (NAFTA), and build a wall along the US-Mexico border – lost the debate.
The Japanese yen, a safe haven currency which benefits from fears of a Trump presidency, weakened while several EM currencies rose as investors’ appetite for risk increased.
Yet it is the peso which is by far the most sensitive financial asset to the perceived outcome of the US election, with investors using the currency as a vehicle to price in the risk of a victory by Trump.
This is not surprising given that more than 80 per cent of Mexico’s exports go to the US and, according to JP Morgan, account for nearly 30 per cent of the country’s economic output. “The ‘Trump premium’ will continue to weigh on [Mexico’s] currency” in the run-up to the US election, JP Morgan notes.
Yet it is not just US political risk that is responsible for the peso’s sharp decline.
Mexico is facing a perfect storm of external and domestic problems.
In addition to “Trump risk”, Mexico, one of the world’s largest oil producers, has been hit hard by the commodities downturn which has contributed to a significant deterioration in the country’s current account and fiscal balances.
The International Monetary Fund is expecting the country’s public debt to reach 55 per cent of GDP this year, compared with less than 40 per cent in 2006.
Government support for the country’s loss-making state-run oil company, Petroleos Mexicanos, or Pemex, has increased the risk of a credit rating downgrade.
And if all this wasn’t bad enough, Luis Videgaray, the architect of Mexico’s structural reforms, quit as finance minister earlier this month because of intense criticism of a meeting he organised between Trump and Mexico’s president, in which the latter played second fiddle to the property tycoon.
Pressure on the peso is unlikely to abate in the run-up to the US election.
Oil prices are set to remain under pressure because of scepticism about a coordinated cut in output given the tensions between the two leading OPEC members, Saudi Arabia and Iran.
Indeed after an initial post-debate rally, the peso was already weakening again on Wednesday.
As Societe Generale noted right after the debate, “Trump didn’t lose badly enough to really reduce the uncertainty” about the outcome of the election.
It is noteworthy that Trump was perceived to have performed poorly in the Republican primary debates earlier this year yet still managed to win the nomination and is now more or less tied with Clinton in the polls.
During the next six weeks, polling data on the outcome of the US election is likely to become increasingly volatile barring a game-changing development in the campaign.
The peso will remain the most reliable measure of US political risk and, as ADM Investor Services rightly notes, markets’ “whipping boy for fears about a Trump presidency.”